Archive for September 2009

Via the indispensable Tyler Cowen, a new paper from Johnson and Fowler explores whether overconfidence is, in fact, adaptive. They show that it it is under some very reasonable assumptions. They model competition for resources as a two-player game and then analyze the evolutionary dynamics of populations playing this game.

The basic result is that overconfidence is beneficial in proportion to two factors: (1) the size of the payoff relative to the cost to play and (2) uncertainty about competitor capabilities. There are two optimal strategies for a population, overconfidence (which minimizes unclaimed resources) and underconfidence (which minimizes conflict costs). Unbiased self-perception is always dominated by these strategies. However, an overconfident person can successfully invade an underconfident population while the reverse is not true. So overconfidence is the stable solution.

The direct implication is that resources get destroyed. It is optimal for an individual to be overconfident, but then he ends up fighting with other overconfident individuals, which imposes costs. If you think about it for a minute, this is a pretty important fundamental problem. All of the big societal decisions we face have potentially big payoffs (or avoidance of costs), but it’s really unclear who has the best expertise to make a recommendation. So we get a bunch of “experts” telling us they are absolutely right.

Note that if it is public knowledge how “good” someone is, the “overconfidence premium” goes to zero. This is why forcing experts to make public predictions is so important. Then you can figure out how good they really are.

Now that we’ve solved the problem of the uninsured, it’s time to move on to the problem of doctor’s visits. Spending on physician and clinical services was $479B in 2007, 22% of total health care spending. Only hospital spending accounts for a larger share at 32% (I’ll be addressing this category in a subsequent post).

First, let me say that I have no problem with increased spending per se. We’ve increased spending on entertainment as well as health care and almost nobody has a problem with that. They’re both signs of increased prosperity. However, our current system encourages an economically inefficient level of spending. That’s the problem we need to fix.

If we want to get close to the efficient level of spending on doctor’s visits, here’s what we need to do:

Eliminate insurance payment of primary care. The risk pooling benefits of insurance only work for rare events or unknown losses. When you use insurance to pay for common events of known magnitude, you are playing the Diner’s Dilemma and most people overconsume. Moreover, you get additional social losses from administrative overhead and reduced incentive to compete on quality. So we should tax any insurance plan that covers primary care (excepting organizations like Kaiser that are paying for essentially all of your care).

Establish personal Health Savings Accounts (HSAs). To reduce the sticker shock of (1), we should give people the ability to pay into personal HSAs roughly the same way they pay into personal IRAs. They will still respond to pricing incentives in the outpatient services market, but the use of pre tax dollars will soften the blow and encourage saving.

Require pricing disclosure. Partly due to strategic behavior in negotiating reimbursement from insurance companies and partly due to wanting to extract the maximum surplus from patients, doctors and labs are reluctant to disclose their prices. Unfortunately, this behavior makes it difficult for patients to respond to pricing signals and decreases service innovation by obscuring differentiation. Therefore, we should require doctors and labs to publicly disclose their general price lists and give patients specific estimates before rendering services.

Eliminate barriers to “Wal-Mart Medicine”. Doctor’s probably like (1). The are probably mixed on (3). They probably won’t like this. One of the reasons that trips to the doctor’s office are so expensive is that they just aren’t very efficient operations. Normally, competition would squeeze out inefficiency but doctors are effectively insulated from competition through a variety of subtle and not-so-subtle regulations. Among the biggest are local restrictions on “retailer clinics” through companies like Wal-Mart and state restrictions on the use of Nurse Practitioners (NPs) and Physician Assistants (PAs). Retailer clinics cost substantially less and provide equivalent care (at least for some basic needs) according to a recent study. Then if you look at salary data from PayScale, NPs and PAs cost about 40% less than family practice doctors. Here, I depart from my usual libertarian bent and advocate using the withholding of federal funds to blackmail encourage local and state authorities to comply.

Fund startups in health advisory and tracking. The first four measures will create a much more open and transparent market for outpatient services. As in other such markets, there are probably a lot of advisory and tracking services that could improve decision making and efficiency. Imagine a self-help applications that advises when a trip to a Wal-Mart clinic is sufficient versus when it’s worth the money to go to a more boutique operation. Or a sophisticated rating and cost comparison services by zip code.

With these measures in place, we would most likely get a richer market that spans Wal-Mart clinics staffed primarily by NPs and PAs that cost $35-50 per visit to high end boutiques where a 30 minute consultation with a star doctor costs $300-$500. Each person would spend much closer to the economically efficient level given their personal circumstances and preferences.

Declan McCullagh of CBSNews reports that a Department of Treasury analysis released under the Freedom of Information Act estimates that a cap and trade program would raise $100B to $200B a year in taxes. Those taxes come from us one way or another. Recall that my estimate of the cost to cover the uninsured is about 2/3rds of that amount ($63B to $126B).

So we have a fortuitous illustration of the tradeoffs we have to make. There are two issues, priorities and effectiveness. It’s not that I don’t think there is some merit to reducing CO2 emissions. Rather, I think there are other problems that are higher priority with solutions that are more likely to be effective. Health care for the poor is one of those. I’m willing to pay an extra $1000/year to solve health care for the poor. I’m not willing to pay an extra $1500/year on top of that to address global warming.

(1) Read Tyler Cowen’s NYTimes column on how the bestowing of political favors was at the heart of the financial crisis and how we’re about to make the same mistake with health care.

(2) Remember Norman Borlaug. He is the scientist who led the “Green Revolution“. In my opinion, he would be a strong candidate for the man who did the most good for the most people in the second half of the 20th Century. And the mainstream media will not make nearly a big enough deal of his death at 95 compared to that of Ted Kennedy.

Yes, I’ve decided to wade into the health care waters again. One of the problems with the current debate is that it confounds several distinct problems. So I’m planning to briefly address each one individually in the hopes of achieving some clarity. First up, the uninsured.

Most of us don’t want people to die simply because they can’t afford basic health care. So I ran the numbers on what it would cost to solve just this problem. The most cost effective approach I know of is a major medical plan plus a health savings account (HSA). According to this Forrester analysis of eHealthInsurance data, the average annual cost of an individual major medical plan in 2007 was $1896.

Premiums have obviously gone up since 2007. However, let’s be optimistic and assume two points of cost savings: having a very large group and following my recommendation of not using insurance for primary care. Let’s put the optimistic annual premium estimate at $1500. Of course, we’re talking about poor people so a no-primary-care major medical plan isn’t enough. We’ll also give them a $300 per year HSA allowance, enough to cover a couple of office visits and some generic drugs plus save up some to pay for a hospital stay. Not that generous, but I’m trying to figure out the minimum cost. Total cost per person: $1800/year.

So how many uninsured are there? Well, estimates vary. But the Census Bureau released a pretty detailed report in 2007. Looking at Table 6 on page 22, we see that there were just over 28,000 uninsured with household incomes below $50K. Now, if we offered a government program means tested to $50K, we’d probably get some people dropping their private insurance for the government insurance. I think only a 25% cross-over would be optimistic. So we have to cover a minimum of 35,000 people at $1800/year. Total cost: $63B/year.

Call it an even $100B due to my optimistic estimates. It will probably add close to $1000/year to my tax bill. I’m willing to pay that. So let’s just do it and then move on to the next problem.